COMMISSIONER OF INCOME TAX, KANPURversusU.P. STATE INDUSTRIAL DEVELOPMENT CORPORATION

A              COMMISSIONER OF INCOME TAX, KANPUR
                                  v.
                U.P. STATE INDUSTRIAL DEVELOPMENT
                             CORPORATION

                                  APRIL 11, 1997
B
                   [S.C. AGRAWAL AND G.T. NANAVATI, JJ.]

          Income Tax Act, 1961 :

          "U11de1w1iting Commission" eamed by assessee in respect of shares,
C which were not s11b.mibed by public, and were purchased by assessee-Held,
    could not be treated as a part of assessee's taxable i11come.

          P.M. Mohammed Meerakhan. v. Commissioner of Income Tax, Kera/a,
    (1969) 73 ITR 735, relied on.
D         Kedar Nath Jute Manufacturing Company v. Commissioner of Income
    Tax, (1971) 82 ITR 363 and Mmvi I11dustries Ltd. v. Commissioner of Income
    Tax, (1971) 82 ITR 835, held not applicable.

        State of Tra11vancore v. Commissioner of Income Tax, (1986) 158 IT~
E 102; Whimsier & Co. v. Commissione1:r of Inland Revenue, 12 T.C. 813 and
    Commissioner of Inland Reve11ue v. Cock Russell & Co. Ltd., 29 T.C. 387,
    referred to.

        Accountancy by William Ribb/es, 3rd Edn., page 1144 (Chapter
  XXVI); Book Keepi11g and Accounts by Emest Evan Spicer a11d Emest C.
F Pug/er, 10th Edn., page 650 Dick.fee's Auditing 17th Edn., pages 279 and
  Auditing Theory and Practice by R.K. Mo11togon11i, 2nd Edn., pages 215· 216,
    referred to.

          Words and Pharases :

G         "Undenwiting'~ "Undenvriting Commission ''-Meaning of

          CIVIL APPELLATE JURISDICTION: Civil Appeal Nos.1739-40
    of 1981.

           From the Judgment and Order dated 30.6.80 of the Allahabad High
H Court in I.T.R. Nos. 31 and 137 of 1976.
                                          846
           C.I.T., KANPUR v. U.P.S.I. DEV. CORPN. [S.C.AGARWAL, J.]       847

           P.A. Choudhary, Dhruv Mehta and B.K. Prasad for the Appellant.        A

           Manoj Swarup and Mrs. Lalitha Kohli for the Respondent.

           The Judgment of the Court was delivered by

            S.C. AGRAWAL, J. These appeals, by certificate granted under         B
    ' Section 261 of the Income Tax Act, 1961 (hereinafter referred to as 'the
      Act'), have been filed by the Revenue against the judgment of the Al-
      lahabad High Court dated June 30, 1980 in Income Tax References Nos.
      31 and 137 of 1976. By the said judgment the High Court has answered the
      following question against the Revenue and in favour of the U.P. State     C
      Industrial Development Corporation (hereinafter referred to as 'the
      assessee') :

             "Whether on the facts and in the circumstances of the case, the
             Tribunal was justified in holding that under writing commission in D
             the case of shares held by the assessee itself and not actually
             subscribed by others was reducing the cost of the shares in the
             hands of the assessee and was not separately taxable as the
             assessee's income of that year?"
.          The references relate to the assessment years 1970-71 and 1971- 72.   E
           The assessee is 3; State undertaking. Its shares are wholly subscribed
     by the State of Uttar Pradesh. It has been incorporated with the object of
     developing industries in the State of Uttar Pradesh and with that end in
     view it finances industrial projects or enterprises, whether owned or run by
     the Government, a statutory body, private company, firm or individuals etc. F
     One of the clauses for financing the company by the assessee was that on
     the shares of such companies subscribed by public the assessce was entitled
     to get commission as well as brokerage on the sale of shares of such
     companies and in case the shares of such companies were not subscribed
     by the public in toto the assessee was obliged to subscribe those shares at G
     face value but was entitled to underwriting commission and brokerage in
     the same manner as if the shares of such companies were subscribed by
     the public. The method adopted by the assessee was that instead of
     crediting the underwriting commission and brokerage to its profit and Joss
     account in the case of such companies the shares of which had to be H
                                                                                   1

    848                   SUPREME COURT REPORTS                 [1997] 3 S.C.R.

A subscribed by the assessee itself, it used to reduce the cost of the shares
  held by it as stock-in-trade. During the previous year relevant to the
  assessment year 1970-71 the assessee had earned by way of underwriting
  commission a sum of Rs. 1,01,250 and brokerage to the extent of Rs. 33,719
  while the assessee offered a sum of Rs. 12,535 out of the aforesaid receipts
B as its taxable income. In the previous year relevant to the assessment year
  1971-72 the assessee earned by way of underwriting commission and
  brokerage a sum of Rs. 1,15,000 and no part of it was included in its taxable
  income. While making the assessment the Income Tax Officer added the
  entire amount received by the assessee by way of underwriting commission
  and brokerage as part of taxable income for both the assessment years. The
c Appellate Assistant Commissioner, however, held that underwriting com-
  mission was assessable as assessees' income in the year in which it accrues,
  i.e., in the year in which the underwriting agreement was made. But as
  regards brokerage he held that brokerage on the shares held by the
  assessee was not includable in the income of the assessee and that it had
D to be adjusted against the cost of the shares taken. The assessee filed
  appeals against the orders of the Appellate Assistant Commissioner before
  the Income Tax Appellate Tribunal (hereinafter referred to as 'the
  Tribunal'). The Revenue did not question the order of the Appellate
  Assistant Commissioner regarding brokerage. The Tribunal held that the
E underwriting commission in respect of the shares held by the assessee
  would reduce the cost of the shares and would not be separately assessable
  as the assessees' income. The Tribunal has observed :


             "And this difference by way of comm1ss10n and brokerage is
F            charged by the underwriter because it agrees to subscribe for a
             large amount of the capital of the company. As such whatever
             amount the underwriter earns as underwriting commission it does
             not automatically become its income. It is postponed unless the
             risk of taking or not taking the shares is over. If the shares are
             fully subscribed, the institution gets commission, hut it does not
G            pay for the capital. In that event, the commission earned by the
             corporation is an income and it could be taken into profit and loss
             account of the assessce. But, if the assessee subscribes some share
             out of the underwritten shares, the commission relating to those
             shares goes towards the cost and, therefore, no income is earned
H            by the underwriter."
I        C.I.T., KANPUR v. U.P.S.I. DEV. CORPN. [S.C.AGARWAL, J.)     849

           After referring to various books on accountancy, namely, Account- A
    ancy by William Ribbles, 3rd Edn., page 1144 (Chapter XXVI); Book
    Keeping and Accounts by Ernest Even Spicer and Ernest C. Pagler, 10th
    Edn., page 650; Dicksee's Auditing, 17th Edn., page 279; and Auditing
    Theory and Practice by R.K. Montogomri, 2nd End., pages 215-216, the
    Tribunal has held that the underwriting account is a part of profit and B
    loss account, which includes not only the income from underwriting
    commission and brokerage but the same is debited by the expenses and
    the cost of shares, which the underwriter is called upon to take and as
    much underwriting commission could not be taken into consideration
    leaving aside the other items of this account. According to the Tribunal,
                                                                            c
    if the nature of the underwriting account is taken into consideration, the
    practice followed by the assessee to first adjust the brokerage and under
    writing commission towards the cost of the shares, which are underwrit-
    ten by it, but the commission and brokerage earned on shares not
    subscribed by it are taken to the profit and loss account, was absolutely
    correct and was in accordance with accountancy principles and, since D
    there is no contrary provision in the Act, the system followed by the
    assessee must be respected. At the instance of the Revenue the Tribunal
    has referred the question above mentioned for the opinion of the High
    Court.
                                                                            E
          The references were considered by the High Court along with
    Income Tax Reference No. 37 of 1976 relating to the assessment years
    1965-66, 1966-67, 1967-68, 1969-70 wherein also similar questton had
    been referred for the opinion of the High Court. The High Court agreed
    with the view of the Tribunal and has held that the commission earned F
    by the assessee as underwriter in respect of the shares offered by the
    company and purchased by the public, would undoubtedly be the profit
    of the assessee which has to be accounted for in its profit and loss
    account, but so far as the shares agreed by the assessee to be under-
    written and purchased by it are concerned, the transaction in substance G
    results in the assessee purchasing those shares for a consideration which
    is equal to the face value of the shares as reduced by the amount of
    commission and brokerage and in such a case, the amount of underwrit-
    ing commission and brokerage merely goes to reduce the value of the
    shares and it cannot be considered to be the income of the assessee. H
    850                  SUPREME COURT REPORTS                   (1997) 3 S.C.R.

A The High Court, however, felt that the question whether the underwriting
    commission in relation to shares which the assessee itself subscribed as
                                                                                   --
    underwriter went to reduce the cost of those shares or whether such
    underwriting commission could be taxed as an income is a substantial
    question of law of general importance and, therefore, it granted certificate
B   of fitness for appeal to this Court under Section 261 of the Act. Hence
    these appeals.

        'in the case of public companies, when shares are offered to the
  public for subscription, it is usual to make certain of obtaining the
  necessary capital by having the shares underwritten. The word "under-
C writing" means that a person agrees lo take up shares specified in the
  underwriting agreement if the public or other persons fail to subscribe
  for them. The consideration for this contract takes the form of payment
  of commission, called "underwriting commission". Underwriters are thus
  paid for the risk they expose themselves to in placing of shares before
D the public. The Payment of underwriting commission is permissible
  under Section 76 of the Companies Act, 1956.

        The question that falls for consideration is whether the underwrit-
  ing commission in respect of shares which could noc be subscribed by
  the public and had to be purchased by the assessee has to be regarded
E as the income of the assessee or it goes towards reducing the cost of
  the shares so purchased. In the accounts maintained by the assessee the
  underwriting commission is first adjusted towards the cost of the shares
  that are underwritten and thereafter the commission on shares not
  subscribed by the assessee is taken to the profit and loss account. The
F Tribunal has found that the said practice followed by the assessee was
  in consonance with principles of accountancy governing underwriting
  account. The Tribunal, after referring to authoritative books on Ac-
  countancy, has held that the underwriting commission is a part of profit
  and loss account which includes not only the income from underwriting
  commission and brokerage but the same is debited by the expenses and
G the cost of shares, which the underwriter is called upon to take and as
  such, undcnvriting commission could not be taken into consideration
  leaving aside the other items of this account and, therefore, the under-
  writing commission in respect of the shares purchased by the assessee
  could not be treated as taxable income in the hands of the assessee. The
H High Court has agreed with the said view of the Tribunal.
           C.l.T., KANPUR v. U.P.S.l. DEV. CORPN. [S.C.AGARWAL, J.)          851

           The main contention urged by the learned counsel appearing for A
     the Revenue in support of the appeals was that the entitlement to
     reduction is to be governed by the provisions of law and not by the
>    accounting practice adopted by the assessee and in support of his submis-
     sion the learned counsel has placed reliance on the decision of this Court
     in Kedar Nath lute Manufactun"ng Company v. Commissioner of I11come
     Tax, (1971) 82 ITR 363; M01vi Industries Ltd. v. Commissioner of Income B
     Tax, (1971) 82 ITR 835 and State of Tranva11core v. Commissioner of
     Income Tax, (1986) 158 ITR 102.

            In our opinion, this contention is devoid of force. The accounting
     practice followed by the assessee in the instant case was in consonance with   C
     general principles of accountancy governing underwriting accounts. It is a
     well accepted proposition that "for the purposes of ascertaining profits and
     gains the ordinary principles of commercial accounting should be applied,
     so long as they do not conflict with any express provision of the relevant
     statute". (See : Whimster & Co. v. Commissioners of Inland Revenue, 12 T.C.    D
     813 and Commissio11ers of Inland Revenue v. Cock, Russell & Co. Ltd., 29
     T.C. 387). This proposition has been affirmed by this Court in P.M.
     Mohammed Meerakhan v. Commissioner of J11come Tax, Kera/a, (1969) 73
     ITR 735. In the said case it has been observed :

             "For that purpose it was the duty of the Income Tax Officer to find    E
             out what profit the business has made according to the true
             accountancy practice." (p. 743)

          The decisions on which reliance has been placed by the learned
     counsel for the Revenue do not depart from this principle.
                                                                                    F
          In Kedar Nath Jute Manufactwing Company v. Commissioner of
     Income Tax (supra) this Court was considering the question whether the
      amount of sales tax paid or payable by the assessee is an expenditure
      within the meaning of Section 10(2)(xv) of the Income Tax Act, 1922.
      The said claim of the assessee was disallowed by the Income Tax Officer G
      on the ground that the assessee was following the mercantile system of
      accounting and had made no provision in its books with regard to
      payment of that amount. Upholding the claim of the assess for deduc-
    .•tion of said amount, this Court has held that whether the assessee is
      entitled to a particular deduction or not will depend on the provision H
                                                                           '1
    852                  SUPREME COURT REPORTS                 (1997] 3 S.C.R.

A of law relating thereto and not on the view which the assessce might take
    of his rights nor can the existence or absence of entries in the books of
    account be decisive or conclusive in the matter. In this case the question
    whether the principles of accounting have to be taken into account for
    ascertainment of profit did not fall for consideration.                      -
B       The decision in M01vi Industries Ltd. v. Commissioner of Income Tax
  (supra) also does not deal with this question. In that case this Court has
  explained the meaning of the word "accrued'' used in Section 4(1)(b)(i) of
  the Income Tax Act, 1922 and has observed that income can be said to
  have accrued when it becomes due and the postponement of the date of
C payment has bearing only so far as time of payment is concerned but it
  does not affect the accrual of income.

          State of Tranvancore v. Commissioner of Income Tax (supra) was a
    case where the assessee-Bank, instead of carrying the interest on sticky
D advances, i.e., advances which had become extremely doubtful of
  recovery, to the profit and loss account, had credited it to a separate
  account called 'the Interest Suspense Account'. The question was
  whether the said interest was taxable, Tulzapurkar J., in his dissenting
  judgment, held that the said income was not an income and was not
E taxable and observed that even in mercantile system of accounting it is
  only the accrual of real income which is chargeable to tax and accrual
  is a matter of substance to be decided on commercial principles having
  regard to the business character of the transactions and the realities and
  specialities of the situation and cannot be determined by adopting a
  purely theoretical or doctrinaire or legalistic approach. The learned
F Judge has referred to standard text books on accountancy to show that
  in case of interest on sticky loans the practice of debiting the accounts
   of the concerned debtors with interest and carrying the same to Interest
   Suspense Account instead of the interest account or profit and loss
   account is well recognised and accepted practice of commercial ac-
G countancy which is wholly consistent with the mercantile system of
   accounting. Sabyasachi Mukharji J. (as the learned Chief Justice then
   was), however, held that the interest on sticky advances had accrued
   according to the mercantile systems of accounting because the assessee-
   Bank had debited the respective parties with the interest and that after
H the close of the accounting year the assessee-Bank without giving UJYthe
      C.I.T., KANPUR v. U.P.S.I. DEV. CORPN. (S.C.AGARWAL, J.)             853

interest, which it could have, as a bad debt, did not offer it for taxation but   A
carried it to the Interest Suspense Account and that carrying a certain
amount which had accrued as interest without treating it as a bad debt or
irrecoverable interest but keeping it in suspense account was repugnant to
Section 36(1)(iii) read with Section 36(2) of the Act. The learned Judge,
after taking note of the recognised books on accountancy to which refer-          B
ence had been made by Tulzapurkar J ., observed :

         "Even if in a given circumstance, the amounts may be treated
         as interest suspense account for accountancy purpose, that
         would not affect the question of taxability as such. This must be
         determined by well-settled legal principles and principles of            C
         accountanc,y which have been referred to hereinbefore".

      Ranganath Misra J. (as the learned Chief Justice then was) con-
curred with reasonings and conclusions of Mukharji J. The aforemen-
tioned observations of Mukharji J. also postulate that for determining            D
the question of taxability well settled legal principles as well as prin-
ciples of accountancy have to be taken into account. In that case the
learned Judge held that without treating the amount which had accrued
as interest as a bad debt or irrecoverable interest but keeping it in
suspense amount was repugnant to Section 36(1)(vii) read with Section
36(2) of the Act and, therefore, even if the amount might be taken to             E
the Interest Suspense Account for accounting purposes, that would not
affect its taxability as such.

      In the present case, the Tribunal after referring to authoritative
book on Accountancy, has found that the assessee was maintaining the F
accounts correctly in accordance with the principles of accountancy
applicable to underwriting accounts and keeping in view the said prin-
ciples the underwriting commission on the shares which were not sub-
scribed by the public and were purchased by the assessee could not be
treated as profit earned by the assessce in the transaction and the said
commission could only be treated as reducing the price of the shares G
purchased by the assessee. The Tribunal has also stated that there is no
contrary provision in the Act. The learned counsel for the Revenue has
not shown that the accountancy practice followed by the assessee is
repugnant to any provision of the Act. In the circumstances, it must be
held that the Tribunal has not committed any error in taking the view H
    854                  SUPREME COURT REPORTS                  (1997] 3 S.C.R.

A that the underwriting commission earned by the assessee in respect of the
    shares which were not subscribed by the public and were purchased by the
    assessee could not be treated as a part of its taxable income. The question
    referred was, therefore, rightly answered by the High Court against the
    Rt:ven ue and in favour of the assessee.

B         As a result, the appeals fail and are accordingly dismissed. No order
    as to costs.

    R.P.                                                    Appeal dismissed.